One of my favourite movie scenes is from Jaws, when Roy Scheider’s character Martin Brody, after seeing the shark for the first time, tells the captain “You’re going to need a bigger boat.” That scene came into my mind in December 2008 in my office at the Treasury when, seeing updated cash-at-bank projections for the Commonwealth Government reflecting the latest disappointing tax collections, it was apparent that the Commonwealth would need to start running much bigger bond auctions and substantially raise the debt limit, then only $75 billion. This was the beginning of the slide into a position of permanent deficit and growing debt (e.g. see chart below). While deficits were inevitable and desirable at the time of the financial crisis, there is no justification for the large $37 billion deficit (2.3% of GDP) we currently have in the 2015-16 financial year.

A good question is why have we failed to repair the budget, particularly when there is widespread agreement that reducing the deficit and limiting the growth of debt is desirable? The answer is possibly the selfishness of current generations, who would rather avoid the necessary austerity measures that would cost them but benefit future generations (through repaying debt and not transferring it on to future generations). An excellent working paper from ANU’s Tax and Transfer Policy Institute published last month presents a computable overlapping generations model illustrating this point (Budget repair measures: Tough choices for Australia’s future). The authors, George Kudrna and Chung Tran, note, regarding three budget repair measures they modeled:

“Even though the long-run benefits of budget repair measures are undeniable, the transitional costs to the economy and welfare are significant and unavoidable. The budget repair measures are indeed tough policy choices for a better future in Australia. Our results consistently suggest that none of the three fiscal austerity measures are politically feasible as they will likely fail to gain the political support of current generations. The conflict of interest between the current and future generations suggests political infeasibility for any structural fiscal reforms.”

So do not expect budget repair any time soon, not solely due to a lack of will from politicians, but partly due to many current voters not really wanting it.

5 Responses to Why is budget repair so difficult?

Great article Gene, I am struggling to comprehend the lack of respect we have for our future generations, driven by an entitlement mentality amongst current generations that seems to hold no bounds. I am 50 and right on the line between boomers and the next generation and I can’t understand the thinking of many around me. To have successful people spend an inequitable amount of time organising assets and investments to ensure some form of government assistance or health concession card later in life is just an indication of why the problem will be so hard to overcome. The attitude I struggle most to compreghend is the ” I paid tax all my life and deserve xyz” Do you know of any material published that deals with this in detail. If someone retired at 65 after 40 years of employment at average median income for example, how many years of retirement would it take for them to have used up all the taxes paid in their life, I think many would be surprised at how much the next generations are subsidising their longevity.

That is a pretty scary chart. Australian governments at all levels have a real spending problem, and the spending problem is for both recurrent and capital expenditure. But I think fixing the capital spending problem is perhaps easier.

For over 150 years, governments have been building infrastructure (roads, hospitals, ports etc) to service the needs of the community. Surely the marginal returns from new capital projects must be falling, so less projects are viable. So why are governments still spending so much on capital formation? Historical capital formation trends (and budgets) should not form the basis for establishing future budgets, because the heavy lifting for social infrastructure development is largely done.

If governments actually applied a bit of economic discipline to their capital formation investments, the slope of that scary debt chart would start to flatten out pretty quickly.

Hi Jim and Gene,
I doubt that it is a case of falling marginal returns on new capital projects. There are a number of areas of infrastructure spending that would give a ‘reasonable’ rate of return. The urban sprawl of Australian cities is some of the most expansive in the world. As these cities expand they will need additional (new) infrastructure in the outer suburbs. If the policy is to increase the population density in the capital cities, there will still be a need for infrastructure. To alleviate the concentration on the capital cities, the regional centres should be developed. That will require infrastructure spending. On top of that, aging infrastructure will need to replaced (e.g. the Westgate Bridge in Melbourne). Gene is right in that there will need to be congestion charging, but not all infrastructure needs to be mega-projects. What is required is for states to have long-term infrastructure plans.